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Moody's United Kingdom Sovereign Downgrade: Yawn

Professor Moorad Choudhry, Department of Mathematical Sciences, Brunel University
Wednesday, 27 Feb 2013 | 1:24 AM ET
City of London
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City of London

As the GDP (gross domestic product), export performance, youth unemployment levels and a myriad other statistics make clear, the U.K. has a plateful of economic problems to contend with right now. A 1-notch downgrade to its credit rating isn't one of them.

The "gold standard" AAA (or Aaa) credit rating has always carried a certain cachet. And I am sure it will continue to. It is after all a sign of impeccable financial strength, of balance sheet quality. But when one is about to jump off a sinking ship, it doesn't matter if the lifeboat comes with leather cushions or not.

The media have focused on the U.K. downgrade as if it was a real big deal, and to one person it particular – the Chancellor, George Osborne – it is. But only because he made it thus. Suggesting that the retention of the country's credit rating is a cornerstone of one's economic policy means that if you lose it it's easy to conclude that said policy is failing. And in a sense it is, but not for the reason's one hears about.

It is illogical to speak of "austerity" when welfare spending has increased by over 15 percent since the present government came to power. Economic policy in the U.K. has been over-reliant on monetary policy and tinkering at the edges of tax policy, while the bottlenecks in the supply side and decreasing productivity go untreated. Debating the impact of a ratings downgrade just takes us further away from the real issues.

Sterling is down at 1.51 against the U.S. dollar but you heard it here first: it will be back to 1.60-1.62 by the end of 2013. U.K. gilt yields will be at or below where they are now in six months. The fears of a "run on the pound" (what a wonderfully old-fashioned, and equally out-dated, notion that is…) are without foundation when every other Western currency looks as ill as GBP does. This isn't the issue.

I mentioned to my dad that the USA was downgraded in 2011 and it hadn't done them any harm. He pointed out that that economy was a fundamentally different beast to the U.K. economy, and also basked in the luxury of the dollar as reserve currency. That is all correct, but the U.K. is also a major economy and people will still want to hold its assets. Everything is relative of course, and they may wish to hold a bit less of sterling than they did in 2012. But the economy hasn't even recovered to 2007 levels, so this is also a bit of a red herring.

If Osborne wants to worry about something genuinely important to the U.K. economy he should consider (1) freezing employer payroll taxes to incentivize job creation (2) removing foreign student entry requirements to boost the university sector, and also remove employment restrictions for foreign postgraduates (3) insisting the British Army pull out of Afghanistan in 2013 rather than 2014, thereby saving the Exchequer about 7 billion (4) using proceeds from the Bank of England's gilt portfolio to pay for infrastructure projects, creating some positive knock-on effect in other sectors, rather than just sinking this cash into the public sector deficit (5) simplifying the tax system, take minimum wage employees out of the tax bracket and remove the pay-tax-receive-tax-credit anomaly, all of which will boost output and finally (6) freezing welfare spending in parallel with cutting VAT, the latter to boost consumer spending.

All of these factors are acting to inhibit U.K. economic performance and keep the country in a state of near-permanent recession. And the country's credit rating impacts them not one jot.

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Professor Moorad Choudhry is at the Department of Mathematical Sciences, Brunel University and author of The Principles of Banking (John Wiley & Sons Ltd 2012).


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